Monitoring a PCCRC

The original idea behind the PCCRC, I thought, was to avoid frequent observations of a position, so I would have time to live my life. My objective was to do a lot of traveling while making money more or less passively.

The PCCRC can make money in several ways. You may have a runaway stock that goes UP 10% or more overnight, making your trade immediately profitable. That is DELTA gains. You may also have stocks that move sideways without the expected rally materializing, and then by the end of the first month, the shorts have lost value, giving you at least some profits. This is Theta gains. It may be that the proximity to a news event or release, may cause the I.V. of the options increase, and you decide to leave the trade, just before the news release. None of these require you to check for Technical analysis signals. You simply wait for an event and just before or after the event, then you leave the trade and take profits. None of these required any knowledge of technical or fundamental analysis.

Now, let's say that the stock rallies, but not overnight, but slow and progressively. Here, your concern is that all rallies come to an end. You don't want to leave the trade prematurely, but you don't want to leave paper profits on the table. What is the right moment to take profits? I suggest you listen to your own gut, or create some rule of some sort, that will allow you to leave the trade without feeling bad if you left too soon. No one can really know what the future holds. What matters is to avoid losses. Note also that it is better to make 10% on your investment in a few days than to make 20% over 5 months. So if a good move has occurred in a very short time, you can take profits by selling calls (if the stock has rallied), or selling puts if the stock has collapsed. In my experience, however, when a stock falls dramatically, it tends to go sideways for a while, or even begin to climb slowly, so it is OK to exit the trade and move on in such cases.

My goal with a PCCRC is to make 20 - 30% for each trade, and to lose no more than 20% in any particular one. This is important to me in terms of money management. I can keep track of 10-15 trades at any particular time. If I have 100,000 to trade, then each one of my trades could be between $7,000 and $10,000. If I lose 20% in a $10,000, I am losing $2,000, or 2% of my capital. I am truly placing only 2% of my capital at risk on any one trade. The PCCRC is hedged in that even in the worse case scenario, I won't lose more than 2% of my capital overnight. But, I know when to exit a trade that is not working out.

It follows that if I make 30% in one trade, I have every reason to exit the position and collect profits. The sooner the better. However, you want to give yourself sufficient time for a strong move in the price of the stock or a big jump in IV to occur, so that profits occurr. You have seen me pick stocks that have jumped 10% or more after earnings. Since we are in earnings season, this may be an excellent time to look for candidates. Take a look at WEBX as an example: The stock was UP more than 10% after earnings, and the company projected increasing earnings above analyst expectations going forward. This after beating expectations by $0.05/share. IV is below 40% and falling, right after earnings. Progressively, IV will begin to climb towards earnings. We want the IV of our long options to increase, while the IV of the short options decline, for Vega gains. The next reporting month for WEBX is July, so we could sell Feb or Mar options, and BUY July options. Going beyond July is fine, but you are buying time you may not need. In the meantime, WEBX may move strongly up in the next few weeks, and give us the Delta gains we want before we exit the trade. Short-term, the stock may go sideways, thus eroding the value of my shorst. Not a bad strategy for those who don't want to focus too much on Technical analysis.

http://biz.yahoo.com/ap/070131/webex_outlook.html?.v=1

I have been quite dogmatic about my IV limits. I don't BUY options with high IV (>40%) and I don't bother with stocks with IV's below 25%. Sometimes, I find stocks with options skews (look at skew finder in Optionetic's Platinum). If I can sell options above 40% and by options at 35%, this may be a pure volatility play. Be sure to test this using Platinum.

Because IV falls after earnings, your exiting position may suffer. Avoid going over earnings if you can. However, if you do, eventually IV's will normalize, so your shorts will lose value quicker but the longs will recover their IV, so don't panic after earnings. Thus, considering exit BEFORE earnings. BUT consider that a strong rally in good earnings may cause an explosion of gains in your position. Before deciding what to do with the trade, I consider how close to the strike price of my position the stock is, what would happen if the stock moves strongly in either direction and assume that IV will collapse.

I recently left a position of GOOG, just before earnings, and I am sure glad I did because my strike price was $500. Drop of IV and stock price is the worse case scenario for the PCCRC. On the other hand, my PCCRC on AMZN had a strike price of $37.5. The stock closed very close to that number of friday. I expect the shorts to lose value very quickly, but the IV of the longs should recover rapidly.

Under any circumstance, earnings are a wild card for ANY options trade. However, if you leave a position just before earnings and the stock rallies, you can always reenter the position at a higher strike price. With any other trade strategy, you can lose all of your investment.

Some of the notes here are in response to questions from our contributer friend PIKO. IF there are further questions, I will address them in the comment sessions to this article. I hope this helps.